Mining the Balance Sheet

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In late February, Levitz Furniture emerged from bankruptcy and merged with rival Seaman Furniture, a deal made possible by an asset- based senior loan instead of a traditional bank loan against cash flow. The $95 million loan, extended primarily by Heller Financial Inc., of Chicago, using Levitz's and Seaman's inventory and receivables as collateral, helped the Woodbury, New York-based Seaman buy out its minority shareholders and the Boca Raton, Florida-based Levitz pay off the debtor-in-possession loan that provided operating funds while it was in reorganization.

Why an asset-based loan rather than a traditional cash-flow loan? Although Seaman is profitable, Levitz had no recent history of positive cash flow. Equally important, economic conditions had turned precarious. "With the economy slowing down, the environment is not conducive to getting a cash-flow loan for companies whose earnings may be impacted by the general economy," says Peter McGeough, former CFO of Seaman and now CFO of Levitz.

Yet the same poor economy leaves midsize companies that have been unstable or are experiencing a drop-off in sales in need of liquidity — most often to finance a turnaround, pay down high levels of debt, carry out a bankruptcy reorganization, or finance the write-off of an underperforming operation. And while cash-flow-based, or unsecured, bank loans are not appropriate for these companies, capital from the shaky stock and bond markets may also be unavailable. But for Levitz and a growing number of companies, asset-based loans are increasingly filling the gap. That's reflected in the total number of outstanding asset-based loans, which more than doubled from 1995 to 1999, the most recent year for which data is available.

A Blank from the Bank

In fact, cash-flow-based loans are increasingly out of reach even for many flourishing small and midsize concerns. That's because banks, under pressure from regulators and hurting from problem loans, are imposing tougher standards and higher rates on all borrowers. As a result, borrowers of all kinds are finding asset-based loans more attractive, and the stigma once associated with this type of lending — that it signified a company down on its luck — has all but disappeared.

In the process, companies are finding that assets other than inventory and receivables can be mined for liquidity. Today, asset-based lenders will lend against the value of practically any asset. And these loans are flexible to the borrower in that they include few if any covenants, though some require control over a company's cash. When seeking to extract liquidity from their real estate, moreover, companies will find that yet another alternative — a sale-leaseback transaction that will not encumber the balance sheet with added debt — has also become more attractive.

While demand for asset-based loans has been growing in the past 9 to 12 months, the growth has been most pronounced since the end of third-quarter 2000. In February, Heller's credit committee was discussing two potential transactions a day, compared with one or two a week one year earlier. The increased demand, lenders say, is coming from all regions equally. Over the past several months, Heller has established new lending teams in Boston, Atlanta, San Francisco, Philadelphia, and Toronto, which broaden its scope beyond Chicago, New York, and Dallas.

"We foresaw a little bit of weakening in the economy, which meant a window of opportunity," says John Goldthorpe, an executive vice president at Heller Corporate Finance. Industrial conglomerate Tyco International sees so much potential here that it announced plans in early March to buy The CIT Group, a New York­based commercial finance company, in a deal initially valued at $9.2 billion.

To be sure, troubled companies still account for most of the demand. CIT says that 80 percent of its new business involves debt restructurings, compared with 50 percent a year ago. Not surprisingly, this demand is greatest in the industries experiencing the most stress — specifically, retail, telecommunications, technology, and media.

But asset-based lending is also attracting young growth companies that don't have a long enough history with a bank to get an unsecured loan, especially in a tight credit market. Case in point: CLP Resources Inc., a Reno, Nevada-based staffing services firm. CLP has more than doubled in size since the late 1990s, to $114 million in revenues last year, and has been pumping profits into working capital to fuel growth. Last November, the company needed to borrow to acquire another temporary-staffing firm. It was able to get a $25 million, three-year facility from Fleet Capital Corp., a unit of Fleet Financial, that was not as restrictive as some asset-based loans in that it allows the company to control its cash accounts, says executive vice president and CFO Bud Little.

While most borrowers are small and midsize companies, large, cash-starved companies have become a definite presence in the market, borrowing $250 million and more at a shot. For example, the $800 million that U.S. retailer Ames Department Stores Inc. recently secured in senior secured financing from General Electric Capital Corp., the finance arm of General Electric Corp., is backed by its inventory, receivables, and real estate. Xerox Corp., struggling to reduce a crushing debt load, is another example, having received $435 million in 18-month financing, also from GE Capital, against the company's U.K. portfolio of lease receivables.

The Kitchen Sink?

Meanwhile, the types of assets that serve as collateral have multiplied. Back in the 1970s, asset-based loans were limited to receivables. Today, anything on the balance sheet qualifies, including inventories, machinery and equipment, real estate, product lines, brands, technological processes, and patents. Lenders prefer to lend against the most liquid assets — receivables and inventory — first, and most asset-based loans are revolving loans backed by those assets. Equipment and property serve as collateral for term loans. Commonly, loans are part revolver and part term. That's what Circuit-Wise Corp., a North Haven, Connecticut, manufacturer of printed wiring boards, has in its $12 million credit line with CIT, which includes a $2 million equipment-backed term loan.

Even though asset-based loans are fully secured, lenders do consider operational issues when deciding whether to lend, and those issues are more important than ever. In contrast to the last recession, when debt restructurings were often all that were needed to turn red ink into black, today many troubled companies not only are highly leveraged but also have unpredictable and typically sagging revenues. "The degree of risk today is different," says Lawrence A. Marciello, group CEO of CIT Commercial Finance. "We really have to buy in on management's execution plan within adverse business conditions."

Of course, even the most credible borrowers cannot borrow against 100 percent of their assets. Lenders first exclude ineligible assets, such as receivables that are more than 90 days overdue. They then typically grant loans worth 85 percent of the value of the remainder, and 50 percent to 65 percent of the value of inventories, with the exact level dependent on the quality of the assets and the risk tolerance of the lender.

Advance rates for inventory are a bit higher than in past years, lenders say, because of improved processes for monitoring the collateral, as well as increased competition. But some inventory is more difficult to value than others, especially such newer types as telecommunication switches, routers, and fiber-optic networks.

Even at 85 percent of receivables or 50 percent of inventory, though, an asset-based loan is often larger than what the borrower can get from a bank. That's because banks are lending at lower multiples of cash flow than they were before the economy started slowing down — two and a half to three times earnings before interest, taxes, depreciation, and amortization versus as much as four times a year ago. In contrast, many companies' assets have not yet declined much in value. "Cash-flow lenders are concerned with cash flow and the ability to repay debt," says Daniel Chapa, business credit executive at Bank of America. "Our focus is not only on cash flow but also on the asset base and what we could collect from that collateral."

Front-end fees, meanwhile, are lower for an asset-based loan because of the lower risk involved with a completely secured loan that is intensively monitored. For midsize companies, those fees hover around 1.5 percent to 2 percent, compared with 2 percent to 2.5 percent for a traditional cash-flow loan. Interest rates on asset-based loans, moreover, are now only slightly higher than those on traditional loans, despite the greater cost incurred by an asset-based lender to keep tabs on the credit — doing periodic appraisals of the collateral and tracking the company's financial progress.

The cost differential, which once was more substantial, has narrowed with competition and greater use of technology. For instance, Fleet Capital's rates on asset-based loans have held steady in the past year, whereas cash-flow lending rates have risen.

Information, Please

On the flip side, asset-based borrowers must provide frequent reports on asset values, which may strike some CFOs as a burden. On top of regular financial reports, for instance, Fred Angelone, CFO of Circuit-Wise, delivers daily data on receivables levels and aging, and weekly information on inventories, to CIT. But Angelone isn't complaining. "It's nothing extraordinary," he says, noting that he needs to have most of this information anyway.

A more serious potential disadvantage is that asset-based loan amounts will fall with a company's fortunes. Witness what recently happened to Circuit-Wise. Because of fewer orders, management had to cut back production, and the company now expects to pull in around $85 million in revenues this year, compared with $103 million in 2000. Meanwhile, however, Circuit-Wise is still paying the same amount of loan interest, which, though based on its assets, has come to represent a higher level of cash flow.

"It's hard for a while," admits Angelone. "You're borrowing at a lower level, while your debt service is higher." Circuit-Wise was lucky, as the strain lasted no more than a month and a half. "We got through it," says the finance chief, "and, thankfully, it was during the holidays," when business was slow.

Still, he felt confident that if the situation had become dire, CIT — which has doubled the company's credit line since starting with it in 1992 — would not have simply cut the company off. A year ago, Circuit-Wise got caught in a price war with imports that put the company in the red and squeezed cash. CIT saved the day with an "over-advance" of $400,000 over a two-month span that the company soon repaid.

That reliability is the reason Lone Star Technologies Inc. believes that an asset-based loan is the best way to go, in good times and bad. The company's major subsidiary, Lone Star Steel Co., which makes steel tubing for the oil industry, switched from a bank to CIT for a $100 million loan facility at the bottom of the oil cycle in March 1999. "Banks are a little more squeamish during the downturns," says Lone Star Technologies CFO Charles J. Keszler, pointing out that it's at the bottom of a cycle that cyclical companies have some of the best acquisition opportunities and need reliable financing. In early 2000, CIT came through when Lone Star wanted to make two acquisitions. Asset-based lenders "don't get scared," he says. "They understand the cycle, and they understand the assets."

These are the kinds of customers that will stay with asset-based lenders even in better economic times. Says Keszler: "I think there's a recognition from treasury management at many corporations of the legitimate role in a company's capitalization that asset-based lending plays."

Hilary Rosenberg is a contributing editor of CFO.

Cash Without Debt?

When considering real estate as a source of liquidity, a company can, of course, take out a loan backed by the property. Alternatively, it can do a sale-leaseback, and real estate professionals say that these transactions have also been on the rise. Dallas-based Staubach Co., for instance, expects to do nearly $1 billion worth of sales in sale-leaseback transactions in 2001, compared with about $800 million in 2000 and $500 million in 1999.

One key advantage of a sale-leaseback is that it does not burden a company's balance sheet with debt, and at this point in the business cycle, many companies have about as much debt as they can handle. "A company has more borrowing capacity if it has completed a sale-leaseback," says Brant Bryan, president of financial services at Staubach. "You've put cash on your balance sheet."

Historically, retailers have been the most common users of sale-leasebacks, but starting about a year ago, a growing number of other types of corporations have plied the technique as well. "Corporate treasurers are seeking asset-based financing methods that are accretive to earnings and [enlarge] credit capacity," says Bryan, noting that more of them are also viewing real estate as an unproductive asset. He cites a 1999 study conducted by the Wharton School's Zell/Lurie Real Estate Center that confirms the long-held suspicion that companies with greater real-estate assets than their peers produce lower shareholder returns.

But companies have also turned to sale-leasebacks as an alternative to the equity and debt markets, which have been unreliable sources of financing in the past year at the same time as real estate has maintained high values. What's more, Bryan says, companies have been attracted by new debt-financing structures that have helped lower the cost of doing sale-leasebacks.

In December, for instance, Staubach helped the oil-exploration company Phillips Petroleum Co. sell its Anchorage headquarters building for $104 million and lease it back for 20 years. With that transaction, plus others, the company could by year's end pay down debt taken on last summer to acquire Arco's 50 percent interest in Alaska's giant North Slope oil field. —H.R.